A concept image of a lit bomb by Leigh Prather via Shutterstock
For a generation of DIY investors, the bond market was essentially a ghost town. When yields were pinned near zero, fixed income was as dead as the vast majority of the cast at the end of the movie Sinners.
Bonds had a well-earned reputation for being a waste of time and money. But not anymore. In fact, here’s a bold statement, one of my boldest of the year so far:
I think that over the next 3 years, the stock market is more likely to be viewed as dead money than bonds will be.
As you can see above, the 10-year US Treasury bond closed Monday at 4.34%. And that’s near its high water mark over the past 10 years. Look out 10 years more, to 20-year bonds, and you’re at 4.89%. While there’s always potential for rates to climb higher, on this simple historical basis, bonds are screaming “buy.”
Inflation can lift rates, and there’s increased potential for loss of faith in the U.S. government. An Iran War whose cost grows significantly with each passing week adds to the risk.
But if you believe that the current level of rates will be competitive over the next couple of decades, it is hard to look away from an investment that can deliver 4.5%-5.% return over that time frame, at least for part of the total portfolio. In my own case, I see it as a way to free up more risk-taking behavior across the non-bond part of my portfolio. Regardless, this is a major change in the so-called “opportunity set” for longer-term investors.
As such, bonds have become the “not so hidden” opportunity. And a mathematical dare for equity-focused investors.
The Equity Risk Premium Collapse
For years, the TINA (There Is No Alternative) narrative drove investors into stocks because bonds paid nothing. Today, that script has flipped. The spread between the S&P 500 Index ($SPX) earnings yield and the 10-year Treasury yield has compressed to its tightest level in two decades. When you can get a guaranteed 4.4% from a government-backed bond, that risk premium for owning volatile tech stocks at 30x earnings begins to look like a bad bet.
Many investors are still anchored to the past, ignoring the fact that high-quality bonds now offer higher yields than the vast majority of dividend-paying stocks. If you are holding a dividend aristocrat yielding 3% while facing the current level of geopolitical risks, you are effectively working harder for less money.
The other aspect of bond investing, even through ETFs: just as with stocks, rising rates which cause bond prices to decline can be hedged. To see how that can work quite cleanly, check out the charts below.
The Invesco Equal Weight 0-30 Year Treasury ETF (GOVI) is a core bond ETF position. Ignore the current trend in the chart. Instead, look at GOVI historically.
Then, look at the Simplify Interest Rate Hedge ETF (PFIX), one of a few ETFs specifically designed to move opposite bond prices. So by combining the pair, and potentially using one to hedge the other in times where there’s upward pressure on interest rates, those intermittent threats to the core bond position do not have to be stressful.
Of course, as I’ve noted here before, the other way to “do bonds” is to ladder a set of them, maturing each year. That can create a predictable cash flow level in retirement. And while that career slowdown might be 10, 20, or 30 years away, the long-term yields are here now, and don’t change after you buy the bonds.
For some, trying to find the next breakout stock is being eclipsed by the simple math of the bond spread. The move here is about tactical balance.
You aren’t abandoning growth. You are simply acknowledging that the “risk-free” rate is now a formidable competitor. It is time to stop treating bonds as a legacy asset and start treating them as the higher-yield bunker they have become.
Rob Isbitts created the ROAR Score, based on his 40+ years of technical analysis experience. ROAR helps DIY investors manage risk and create their own portfolios. For Rob’s written research, check out ETFYourself.com.
On the date of publication, Rob Isbitts did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.